Up-to-the-minute advice, information, resources, and, on occasion, commentary on federal and New Jersey state income taxes, and the various New Jersey property tax rebate programs, and insights and observations on tax policy and professional tax practice, by 40-year veteran tax professional Robert D Flach.

Monday, October 24, 2011

THE NEW FORM 1099-K CREATES NEW PROBLEMS

Beginning with tax year 2011 payments made to businesses by credit card companies and “third-party networks” (resulting from customers using a credit card or PayPal to pay a vendor for merchandise or services) during the calendar year must be reported to the business, and to the IRS, on new IRS information return Form 1099-K.

As a result of this new requirement
the IRS has revised the 2011 Schedule C, in its current draft version, to break
down gross receipts into three (3) separate categories -

Line 1a = Gross merchant card and
third party network receipts and sales (see instructions)

Line 1b = Gross receipts or sales
not entered on Line 1a

Line 1c = Income reported to you on
Form W-2 if the “Statutory Employee” box on that for was checked

Line 1d = Total Gross Receipts

The instructions for Line 1a state –

“Enter
on this line payments you received in your trade or business through merchant
cards and third party networks.These
payments should have been reported to you in Box 1 of Form 1040-K, Merchant
Card and Third Party Network Payments.Also include on this line payments received through merchant cards and
third party networks that may not have been reported on Forms 1099-K that you
received.Merchant cards include, but
are not limited to, Visa and MasterCard.Third party networks include, but are not limited to, Paypal and Google
Checkout.”

FYI, the draft instructions for Form 1099-K have not yet been released.However Box 1 of the Form 1099-K is identified as “Gross amount of merchant card/third party network payments”.

“. . .the amounts on the Form 1099-K’s will not match true sales. First, these amounts will
include sales tax, shipping, and other non-sales charges. Second, the amounts
on the Form 1099-K’s will be reported using cash basis. Any business that is
accrual basis will have matching issues. Third, the reporting will likely be
meaningless for any business that reports on a fiscal (non-December year-end)
year {although I should point out that a monthly breakdown of gross
receipts is included on the draft 2011 Form 1099-K Boxes 5a – 5l - rdf}.”

I expect that, for expediency sake,
Schedule C filers, and tax professionals should do as Russ suggests -

“The
solution that I expect most businesses to use is to just use the Form 1099-K to
populate this line. It’s simple, and guarantees that there will be no matching
problems. Of course, that puts the cart before the horse but if you’re a
business owner or a tax professional this solution is likely the one that
lessens the risk of an audit.”

I expect this is what I will do for the
very few clients where this will apply.

If a business determines that it has
$100,000 of gross sales for 2011, and it receives Form 1099-Ks whose Box 1 total
$48,000, it would enter $48,000 in Box 1a, $52,000 in Box 1b, and $100,000 in
Box 1d on Schedule C.

This method is not strictly a true
reporting.As Russ mentions, the amount
entered in Box 1 of Form 1099-K will be the gross payments made by the
third-party, and will include sales tax and other charges.While shipping and other charges can be
deducted out in the expense section of Schedule C, sales tax collections, and
the remittance thereof, should not be reported anywhere on the Schedule C.

If the amount
reported in Box 1 is $50,000, and this includes $3,200 in sales tax collected,
the true amount entered on Line 1a should be $46,800.But if the lower amount is entered the number
would not “match” the Form 1099-K received by the IRS, and could result in an
inquiry or an audit.

I do not know if
all third party payers have sufficient information to identify sales tax
assessments included in gross payments, so correcting the Form 1099-K to report
gross payments less sales tax, or also
separately report sales tax included in the Box 1 amount, may not be the
answer.

Similar changes
have been made to 2011 corporation and partnership returns, and the 2011
Schedule E.Lines 3a and 3b on the
Schedule E are similar to Lines 1a and 1b on the Schedule C, and the instructions
for Line 3a are basically the same as for the Schedule C. While corporations and partnerships will experience the
same problems as Schedule C filers, this should not cause problems for Schedule
E filers, as there is no sales tax collected on monthly rental payments.

Another problem
presents itself.What about a customer
who issues a vendor a Form 1099-MISC for “nonemployee compensation” in the amount
of $5000, which was paid via credit card, or PayPal.The business will receive a Form 1099-MISC from
the customer and a Form 1099-K from the credit card processing company, or
PayPal, for the same income!How will
this affect the IRS “matching” program?

9 comments:

The new instructions for Form 1099-MISC state that payments made by credit cards are not supposed to be included on Form 1099-MISC. Unfortunately, most businesses don't have the ability to separate these out so this is yet another potential issue with the new Form 1099-K.

And how about - "If it is broke, but can be fixed, Congress will make sure it ends up on the garbage heap."

To the other RF -

Thanks for the word.

I agree with your "unfortunately", and would add that unfortunately few tax preparers, and hardly any taxpayers, actually read the instructions for an ongoing form. So the result will undoubtedly be problems.

Hello Robert, I was quoting the post above me. I realize this wasn't your quote. One question I have about 1099k is if a person uses a third party processor like Paypal, for example, a person has money in their Paypal account from sales. That merchant keeps the funds in their Paypal account for a few weeks or months and then decides to transfer it to their bank account. Does the bank now consider this a sales transaction and the bank will now send a 1099k even if that person has not reached the thresholds from Paypal to receive a 1099k? Also, if someone were to open a new Paypal account in 2011, Paypal would have to verify the persons bank account by adding .21(cents) to that bank account. As silly as it sounds, would the bank see that as a transaction and send a 1099k just for a .21 transfer? I only ask because there is no threshold on transactions with a bank.

Banks only report on Form 1099-K money received via credit or debit card charges. I do believe money transferred in from PayPal is done via a wire transfer and not through a credit or debit card, and should not be reported on a Form 1099-K by the bank.

Thank you for answering Robert. Paypal tranfers are made through an ACH when being transfered into a bank account. Not being a tax pro myself, from the statement below, I read it as a PSE to be a bank,and they would issue the 1099k even if it's a third party like Paypal. Or am I just confused in thinking this or reading it the wrong way? This is from the IRS 1099k instruction link.

"A payment settlement entity (PSE) must file Form 1099-K for payments made in settlement of reportable payment transactions for each calendar year. A PSE makes a payment in settlement of a reportable payment transaction, that is, any payment card or third party network transaction, if the PSE submits the instruction to transfer funds to the account of the participating payee to settle the reportable payment transaction."

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